Payback period Calculate the payback period and ARR for an investment. Analyze the results of the calculations
All investments begin with an element of risk. Total risk aversion will in essence mean that no investment can take place. However, the degree of risk in a business investment is generally associated with returns on the investment.
In the production process it is the aim of the entrepreneur to be not only creative and take the risk involved in putting together the other elements of the production process, but to also minimize this risk as much as possible, while at the same time gauging the feasibility of the venture. The aim of investment appraisal and the methods used in the section is to determine the degree of risk involved in the investment. Prior to targeting and securing a source of finance, entrepreneurs have a medley of tools at their disposal that serve to minimize this risk. It is also in the interest of the individuals or institutions providing the source of finance to be appraised of the risks they are taking, thereby making them more open to providing the requested resources. Banks and other lenders often want to be appraised of the prospects of the investments and in this light, investment appraisal should be taken as a first critical step.
If funds are indeed loaned towards the investment, the objective will be to repay them as soon as possible. This is primarily on account of the costs associated with a loan, interest. Therefore, the investment appraisal method used to calculate the expediency in the repayment of a loan is known as the payback period. This method has its limitations and advantages which we shall also examine. However, the payback period allows entrepreneurs to choose between two or more projects and to calculate to the second, hour, week, month or year when the investment can be paid back.
Let us assume that you have an investment that yields $300,000 per year and $600, 000 was loaned toward the venture. Through a simple calculation we can determine that it will take two years to repay the investment. The formula for this calculation is
Payback period = Yearly Cash Flow ÷ Initial Cost of the Investment
Time Period
Cash flow
Initial Investment
Year 1
300,000
600,000
Year 2
300,000
Year 3
300,000
Year 4
300,000
Total 4 years
1,200,000
Figure 1.
300,000 ÷ 600,000 = 2 years payback period
Note however, that in this overly simplistic example, in Figure 1 the yearly cash flow is the same and the payback period does not fall between the months of the year. When the above formula is applied, once again the annual cash-flow must be the same for the periods in question.
When the payback period is to be calculated to the month or to the day the following formula shown below is applied.
Project One in figure 2.
Initial Investment less the annual payback to per year to determine the year within which the payback period will occur. Therefore
$750,000 - $300,000 (year one) = $450,000 - $300,000 (year two) = 150,000 (to be covered in year three)
The formula for this calculation is
Payback required difference ÷ Cash flow for the Period = payback period within the year in decimal x 12(for months) or 365 for days or 52 for weeks.
Time Period
Cash flow Project One
Cash Flow Project Two
Initial Investment
Year 1
300,000
200,000
750,000
Year 2
300,000
100,000
Year 3
300,000
250,000
Year 4
300,000
300,000
Total 4 years
1,200,000
850,000
Figure 2.
It has been quickly ascertained that the time period for Project One will fall between year 2 and year 3. The difference in the payback required difference which will be paid back in the third year is 900,000 – 750,000 = 150,000
Therefore we can now use the formula to determine the seconds, minutes, hours, days, weeks, or months needed for the payback!
150,000 ÷ 300,000 = 0.5 x 12 (months) = 6 months
Therefore the investments will be repaid in 2 years and 6 months
Project Two in figure 2. Initial Investment less the annual payback to per year to determine the year within which the payback period will occur. Therefore
$750,000 - $200,000 (year one) = $550,000 - $100,000 (year two) = $450,000 – $250,000 (year three) = $200,000 (to be covered within the fourth year)
Payback required difference ÷ Cash flow for the Period = payback period within the year in decimal x 12(for months) or 365 for days or 52 for weeks.
It has been quickly ascertained that the time period for Project Two will fall between year 3 and year 4. The difference in the payback required difference which will be paid back in the fourth year is
$650,000 – $750,000 = $100,000
Therefore we can now use the formula to determine the seconds, minutes, hours, days, weeks, or months needed for the payback!
Therefore the investments will be repaid in 4 years and 4 months, or 4 years and 122 days (.333 x 365.25).
The results of this calculation reveal to us the speed within which the payback can take place between projects. In this case Project One will be repaid faster.
Average rate of return (ARR)
Once it has been ascertained that a particular investment loan could potentially be paid back within an acceptable period of time, another logical question is what the return is on the investment. Investors may set minimum requirements on the gains to be made from their investment on a yearly basis, which we refer to as annualized returns. This represents the Average rate of Return on a given investment. This calculation is not to be confused with the Accounting rate of Return which is computed by taking the aggregate expected income from a project and dividing this by the expected investment. The Average Rate of Return in place of aggregate net income calculates for the average profit income in the numerator.
The formula for this calculation is
Annualized Net Profit ÷ initial Investment x 100/1 = Average rage of Return as a percentage
The ARR for Project One in figure 2 is calculated by first determining the total cash flow
$300,000 (year 1) + $300,000 (year 2) + $300,000 (year 3)+ $300,000 (year 4) = $1,200,000 (Gross Profit) less the initial investment of $750,000 = $450,000 (Net Profit) ÷ 4 years = $112,500 Annualized Net profit ÷ $750,000 (initial investment) = .15 x100/1 = 15% ARR
The ARR for Project Two in figure 2 is calculated by first determining the total cash flow
$200,000 (year 1) + $100,000 (year 2) + $250,000 (year 3)+ $300,000 (year 4) = $850,000 (Gross Profit) less the initial investment of $750,000 = $100,000 (Net Profit) ÷ 4 years = $25,000 Annualized Net profit ÷ $750,000 (initial investment) = .0333 x100/1 = 3.3% ARR
Analyzing the results of the calculations
Once again Project One in figure 2 shows a higher Average Rate of Return and a shorter Payback Period. Although this information does serve the purpose of highlighting specific outcomes between projects there are specific limitations and certain advantages that need to be clearly understood.
Unfortunately a shorter payback period does not necessarily mean that Project One is a more desirable investment. The payback method does not consider what transpires beyond the payback period. It ignores all cash flows that occur after the payback period. To illustrate, let us take a look at Project One and Two once again in Figure 3.. Although Project Two pays back in 4 years and 4 months, while Project One pays back in 2 years and 6 months, assume that Project Two’s cash flows double in year 5 to $600,000 and in year 6 to $1,200,000.
Time Period
Cash flow Project One
Cash Flow Project Two
Initial Investment
Year 1
300,000
200,000
750,000
Year 2
300,000
100,000
Year 3
300,000
250,000
Year 4
300,000
300,000
Year 5
0
600,000
Year 6
0
1,200,000
Total 6 years
1,200,000
2,650,00
Figure 3.
Under these circumstances payback is not a true measure of the profitability of an investment. As a result, the tool may not accurately estimate the value of the project whose benefits occur after the initial investment costs are repaid. In this second scenario, assume that Project One becomes useless in the 5th year, once again illustrating limitation to the uses of the payback method. In addition associated risks of an investment and the opportunity costs of capital are not accounted for in this methodology. These exclusions mean that decisions are made on an absolute basis and thereby potentially overvalue the investments.
On the other hand, the payback approach is simple and can be very useful as a screening tool for businesses that are “cash strapped”, or for those that buy equipment with short life spans i.e. become obsolete very quickly. However, another major limitation is that the payback method ignores the time value of money. In other words, the future cash flows must be recalculated to represent their present value. This important topic will be explored in the next section.
The shortcomings of the Average Rate of Return are that the profits are averaged over the period being considered while the time value of money is also ignored.
Therefore, in Figure 2 Project One and Project Two vary considerably in their ARR (15% and 3.3% respectively). However, the longer the period of time in which the returns are determined the more significant becomes the time value of money.
HL ONLY Discounted cash flow (DCF) Calculate the NPV for an investment. Analyse the results of the calculations.
This area of learning is generally more difficult for students to grasp because of the abstract nature of time. When the Time Value of Money is taken into consideration, the purpose is to take into account interest rates that could have been earned.
Consider the following situation. If your friend gave you two options in repaying you money owed and the first option was to repay you immediately while the second option was to repay you in 5 years time, which option is more acceptable?
Clearly having the money in your pocket now is a more fulfilling choice, however, the more accurate reason for Option one is that the value of your money is realizable at the present moment. This Present Value of your money implies that you have immediate and current purchasing power. Option Two, however, not only denies you this immediate value but any value that may accrue between the Present and 5 years from now. This unaccounted time in which YOUR money could have earned you interest from a bank or is what we would call the Time Value of Money. Therefore if the amount that your friend owed you was $100 and you could have deposited the money and earned 10 % interest on it per year, the value you lost would have been equivalent to 10% per year for the 5 years.
At the end of the first year it would be worth $110 ($100 + $100 x 10%) or ($100 x 1.1)
At the end of two years it would be worth $121 ($110 + 110 x 10%) or ($110 x 1.1)
At the end of three years it would be worth $133 ($121 + 121 x 10%) or ($121 x.1.1)
At the end of four years it would be worth $146.41 ($133 + 133 x 10%) or ($133 x 1.1)
At the end of five years it would be worth $161.05 ($146.41 + 146.41 x 10%) or ($146.41x.1.1)
This shows that money grows over time if interest is paid on the amount deposited. In other words the money that your fried promised to pay you in 5 years time will be worth more in the future than in the present because it could have been place in an interest earning account. In five years time you could have earned $61.05 in interest alone. Therefore the total value of the $100 would have accrued or grown to $161.05.
The Discounted Cash Flow takes account the Present Value of money that could have been earned on future cash flows. This is simply a reversal of the aforementioned example. Assume that you wish to earn $500 in 5 years time, how much money would you have to place in a bank account NOW in order to have the Future Value of $500 in 5 years time? If the bank still offers 10% interest the following formula would be used for your calculation.
Present Value =
Where A is the Amount of Money, r is the rate of interest per period, and n is the number of years.
= = $309.59
Therefore $309.59 would need to be deposited in a 10% interest bearing account for 5 years to yield the Future Value of $500. The Discounted Cash Flow takes into account that the rate of interest remains the same. However, income streams may vary as in the case below. Lets use assume that our two investment project illustrated in figure 2. Both of which cost the same amount of $750,000 are to be discounted to their present value.
The present value of $1 over five years at 10% would be as follows:
After
0 years
1 year
2 years
3 years
4 years
5 years
Present Value of $1
$1
$0.909
$0.826
$0.751
$0.683
$0.620
= 0.909 = 0.826
= 0.751
= 0.683 = 0.620
Time Period
Cash flow Project One
Discounted Cash Flow Project One
Cash Flow Project Two
Discounted Cash Flow Project Two
Initial Investment
Year 1
$300,000 x 0.909
$272,700
$200,000 x 0.909
$181,800
$750,000
Year 2
$300,000 x 0.826
$247,800
$100,000 x 0.826
$85,600
Year 3
$300,000 x 0.751
$225,300
$250,000 x 0.751
$187,750
Year 4
$300,000 x 0.683
$204,900
$300,000 x 0.683
$204,900
Year 5
0
0
$600,000 x 0.620
$372,000
Total 5 years
$1,200,000
$745,800
$1,450,000
$1,032,050
Figure 3.
The present value of the future cash flow for Project One is $745, 800 while the future cash flow for Project Two is $1, 032,050. Before the Discounted Cash Flow calculation, Project One would have been thought to be more profitable at $1,200,000 and Project Two would also have been overvalued at $1,450,000. The question that now arises is whether both projects are profitable. To answer this question we need to calculate the Net Present Value.
Once we subtract initial costs from the present value of return we arrive at the Net Present Value.
Net Present value = Present Value of Return – Initial cost
For the investment to be profitable we would have to have a NPV greater than zero. However, by comparing two or more projects we can also quickly determine which is more profitable and thereby make a decision on the basis of the greater returns. If the NPV is less than zero, this simply means that the costs relative to the present value of return are higher and that no profit will be made.
From our two projects in Figure 4 the calculations for the NPV would be as follows:
Time Period
Cash flow Project One
Discounted Cash Flow Project One
Cash Flow Project Two
Discounted Cash Flow Project Two
Initial Investment
Year 1
$300,000 x 0.909
$272,700
$200,000 x 0.909
$181,800
$750,000
Year 2
$300,000 x 0.826
$247,800
$100,000 x 0.826
$85,600
Year 3
$300,000 x 0.751
$225,300
$250,000 x 0.751
$187,750
Year 4
$300,000 x 0.683
$204,900
$300,000 x 0.683
$204,900
Year 5
0
0
$600,000 x 0.620
$372,000
Total 5 years
$1,200,000
$745,800
$1,450,000
$1,030,050
Minus Cost
$750,000
Minus Cost
$750,000
Net Present Value
- $4,200
Net Present Value
$282,050
Figure 4.
Project one has a NPV that is negative, meaning that relative to the time value of money and the cost of the investment no returns are being made that cover the initial investment of $750,000. However, project two does yield a NPV of $282, 050 that this project is worth the investment, while taking into account the 10% time returns in calculating the time value of money. This is indeed the advantage of this method of investment appraisal. It deals with the problem of interest rates and time.
Having said that, there are, however other factors that should be considered which will influence the decision maker. In sum, no investment project can be approved if it is not in line with the overall corporate strategy of the business or if the availability of funding for investments, due to future or current cash flow problems, will negatively impact the organization. Although the DCF does not factor in the effects of inflation, many capital investment decisions involve the replacement of existing assets and as such non-financial factors as well as income tax effects are part of the overall decision making approach.
Reflection Point
In the following activity, reflect on how you would advise the company using as many aspects of what you have learned in Investment Appraisal. HL students must use the DCF to calculate the NPV. The present value of Rupee 1 over five years at 10% would be as follows:
After
0 years
1 year
2 years
3 years
4 years
5 years
Present Value of $1
Re1
Re0.909
Re0.826
Re0.751
Re0.683
Re0.620
A Business in India with an yearly turnover of (in Rupees) Rs300 billion rupees has decided to buy new computers to help improve its business. The computers will be placed in a new location which must be constructed. The cost of the construction as advised by the contractors is Rs250Million and will take 5 years. The cost of 100 Computers will be Rs800,000. The Anticipated Cash flow in all years is Rs56million.
IB Corner
State the advantages and limitations of Investment Appraisal when using the:
1) Payback period 2) Average Rate of return 3) Discounted Cash Flow and Calculating the NPV
Payback period
Calculate the payback period and ARR for an investment.
Analyze the results of the calculations
All investments begin with an element of risk. Total risk aversion will in essence mean that no investment can take place. However, the degree of risk in a business investment is generally associated with returns on the investment.
In the production process it is the aim of the entrepreneur to be not only creative and take the risk involved in putting together the other elements of the production process, but to also minimize this risk as much as possible, while at the same time gauging the feasibility of the venture. The aim of investment appraisal and the methods used in the section is to determine the degree of risk involved in the investment. Prior to targeting and securing a source of finance, entrepreneurs have a medley of tools at their disposal that serve to minimize this risk. It is also in the interest of the individuals or institutions providing the source of finance to be appraised of the risks they are taking, thereby making them more open to providing the requested resources. Banks and other lenders often want to be appraised of the prospects of the investments and in this light, investment appraisal should be taken as a first critical step.
If funds are indeed loaned towards the investment, the objective will be to repay them as soon as possible. This is primarily on account of the costs associated with a loan, interest. Therefore, the investment appraisal method used to calculate the expediency in the repayment of a loan is known as the payback period. This method has its limitations and advantages which we shall also examine. However, the payback period allows entrepreneurs to choose between two or more projects and to calculate to the second, hour, week, month or year when the investment can be paid back.
Let us assume that you have an investment that yields $300,000 per year and $600, 000 was loaned toward the venture. Through a simple calculation we can determine that it will take two years to repay the investment.
The formula for this calculation is
Payback period = Yearly Cash Flow ÷ Initial Cost of the Investment
300,000 ÷ 600,000 = 2 years payback period
Note however, that in this overly simplistic example, in Figure 1 the yearly cash flow is the same and the payback period does not fall between the months of the year. When the above formula is applied, once again the annual cash-flow must be the same for the periods in question.
When the payback period is to be calculated to the month or to the day the following formula shown below is applied.
Project One in figure 2.
Initial Investment less the annual payback to per year to determine the year within which the payback period will occur. Therefore
$750,000 - $300,000 (year one) = $450,000 - $300,000 (year two) = 150,000 (to be covered in year three)
The formula for this calculation is
Payback required difference ÷ Cash flow for the Period = payback period within the year in decimal x 12(for months) or 365 for days or 52 for weeks.
Project One
Project Two
It has been quickly ascertained that the time period for Project One will fall between year 2 and year 3. The difference in the payback required difference which will be paid back in the third year is
900,000 – 750,000 = 150,000
Therefore we can now use the formula to determine the seconds, minutes, hours, days, weeks, or months needed for the payback!
150,000 ÷ 300,000 = 0.5 x 12 (months) = 6 months
Therefore the investments will be repaid in 2 years and 6 months
Project Two in figure 2.
Initial Investment less the annual payback to per year to determine the year within which the payback period will occur. Therefore
$750,000 - $200,000 (year one) = $550,000 - $100,000 (year two) = $450,000 – $250,000 (year three) = $200,000 (to be covered within the fourth year)
Payback required difference ÷ Cash flow for the Period = payback period within the year in decimal x 12(for months) or 365 for days or 52 for weeks.
It has been quickly ascertained that the time period for Project Two will fall between year 3 and year 4. The difference in the payback required difference which will be paid back in the fourth year is
$650,000 – $750,000 = $100,000
Therefore we can now use the formula to determine the seconds, minutes, hours, days, weeks, or months needed for the payback!
$100,000 ÷ $300,000 = 0.333 x 12 (months) = 4 months
Therefore the investments will be repaid in 4 years and 4 months, or 4 years and 122 days (.333 x 365.25).
The results of this calculation reveal to us the speed within which the payback can take place between projects. In this case Project One will be repaid faster.
Average rate of return (ARR)
Once it has been ascertained that a particular investment loan could potentially be paid back within an acceptable period of time, another logical question is what the return is on the investment. Investors may set minimum requirements on the gains to be made from their investment on a yearly basis, which we refer to as annualized returns. This represents the Average rate of Return on a given investment. This calculation is not to be confused with the Accounting rate of Return which is computed by taking the aggregate expected income from a project and dividing this by the expected investment. The Average Rate of Return in place of aggregate net income calculates for the average profit income in the numerator.
The formula for this calculation is
Annualized Net Profit ÷ initial Investment x 100/1 = Average rage of Return as a percentage
The ARR for Project One in figure 2 is calculated by first determining the total cash flow
$300,000 (year 1) + $300,000 (year 2) + $300,000 (year 3)+ $300,000 (year 4) = $1,200,000 (Gross Profit) less the initial investment of $750,000 = $450,000 (Net Profit) ÷ 4 years = $112,500 Annualized Net profit ÷ $750,000 (initial investment) = .15 x100/1 = 15% ARR
The ARR for Project Two in figure 2 is calculated by first determining the total cash flow
$200,000 (year 1) + $100,000 (year 2) + $250,000 (year 3)+ $300,000 (year 4) = $850,000 (Gross Profit) less the initial investment of $750,000 = $100,000 (Net Profit) ÷ 4 years = $25,000 Annualized Net profit ÷ $750,000 (initial investment) = .0333 x100/1 = 3.3% ARR
Analyzing the results of the calculations
Once again Project One in figure 2 shows a higher Average Rate of Return and a shorter Payback Period. Although this information does serve the purpose of highlighting specific outcomes between projects there are specific limitations and certain advantages that need to be clearly understood.
Unfortunately a shorter payback period does not necessarily mean that Project One is a more desirable investment. The payback method does not consider what transpires beyond the payback period. It ignores all cash flows that occur after the payback period. To illustrate, let us take a look at Project One and Two once again in Figure 3.. Although Project Two pays back in 4 years and 4 months, while Project One pays back in 2 years and 6 months, assume that Project Two’s cash flows double in year 5 to $600,000 and in year 6 to $1,200,000.
Project One
Project Two
Under these circumstances payback is not a true measure of the profitability of an investment. As a result, the tool may not accurately estimate the value of the project whose benefits occur after the initial investment costs are repaid. In this second scenario, assume that Project One becomes useless in the 5th year, once again illustrating limitation to the uses of the payback method. In addition associated risks of an investment and the opportunity costs of capital are not accounted for in this methodology. These exclusions mean that decisions are made on an absolute basis and thereby potentially overvalue the investments.
On the other hand, the payback approach is simple and can be very useful as a screening tool for businesses that are “cash strapped”, or for those that buy equipment with short life spans i.e. become obsolete very quickly. However, another major limitation is that the payback method ignores the time value of money. In other words, the future cash flows must be recalculated to represent their present value. This important topic will be explored in the next section.
The shortcomings of the Average Rate of Return are that the profits are averaged over the period being considered while the time value of money is also ignored.
Therefore, in Figure 2 Project One and Project Two vary considerably in their ARR (15% and 3.3% respectively). However, the longer the period of time in which the returns are determined the more significant becomes the time value of money.
HL ONLY
Discounted cash flow (DCF)
Calculate the NPV for an investment.
Analyse the results of the calculations.
This area of learning is generally more difficult for students to grasp because of the abstract nature of time. When the Time Value of Money is taken into consideration, the purpose is to take into account interest rates that could have been earned.
Consider the following situation. If your friend gave you two options in repaying you money owed and the first option was to repay you immediately while the second option was to repay you in 5 years time, which option is more acceptable?
Clearly having the money in your pocket now is a more fulfilling choice, however, the more accurate reason for Option one is that the value of your money is realizable at the present moment. This Present Value of your money implies that you have immediate and current purchasing power. Option Two, however, not only denies you this immediate value but any value that may accrue between the Present and 5 years from now. This unaccounted time in which YOUR money could have earned you interest from a bank or is what we would call the Time Value of Money. Therefore if the amount that your friend owed you was $100 and you could have deposited the money and earned 10 % interest on it per year, the value you lost would have been equivalent to 10% per year for the 5 years.
At the end of the first year it would be worth $110 ($100 + $100 x 10%) or ($100 x 1.1)
At the end of two years it would be worth $121 ($110 + 110 x 10%) or ($110 x 1.1)
At the end of three years it would be worth $133 ($121 + 121 x 10%) or ($121 x.1.1)
At the end of four years it would be worth $146.41 ($133 + 133 x 10%) or ($133 x 1.1)
At the end of five years it would be worth $161.05 ($146.41 + 146.41 x 10%) or ($146.41x.1.1)
This shows that money grows over time if interest is paid on the amount deposited. In other words the money that your fried promised to pay you in 5 years time will be worth more in the future than in the present because it could have been place in an interest earning account. In five years time you could have earned $61.05 in interest alone. Therefore the total value of the $100 would have accrued or grown to $161.05.
The Discounted Cash Flow takes account the Present Value of money that could have been earned on future cash flows. This is simply a reversal of the aforementioned example. Assume that you wish to earn $500 in 5 years time, how much money would you have to place in a bank account NOW in order to have the Future Value of $500 in 5 years time? If the bank still offers 10% interest the following formula would be used for your calculation.
Present Value =
Where A is the Amount of Money, r is the rate of interest per period, and n is the number of years.
Therefore $309.59 would need to be deposited in a 10% interest bearing account for 5 years to yield the Future Value of $500. The Discounted Cash Flow takes into account that the rate of interest remains the same. However, income streams may vary as in the case below.
Lets use assume that our two investment project illustrated in figure 2. Both of which cost the same amount of $750,000 are to be discounted to their present value.
The present value of $1 over five years at 10% would be as follows:
Project One
Project Two
The present value of the future cash flow for Project One is $745, 800 while the future cash flow for Project Two is $1, 032,050. Before the Discounted Cash Flow calculation, Project One would have been thought to be more profitable at $1,200,000 and Project Two would also have been overvalued at $1,450,000. The question that now arises is whether both projects are profitable. To answer this question we need to calculate the Net Present Value.
Once we subtract initial costs from the present value of return we arrive at the Net Present Value.
Net Present value = Present Value of Return – Initial cost
For the investment to be profitable we would have to have a NPV greater than zero. However, by comparing two or more projects we can also quickly determine which is more profitable and thereby make a decision on the basis of the greater returns. If the NPV is less than zero, this simply means that the costs relative to the present value of return are higher and that no profit will be made.
From our two projects in Figure 4 the calculations for the NPV would be as follows:
Project One
Project Two
Figure 4.
Project one has a NPV that is negative, meaning that relative to the time value of money and the cost of the investment no returns are being made that cover the initial investment of $750,000. However, project two does yield a NPV of $282, 050 that this project is worth the investment, while taking into account the 10% time returns in calculating the time value of money. This is indeed the advantage of this method of investment appraisal. It deals with the problem of interest rates and time.
Having said that, there are, however other factors that should be considered which will influence the decision maker. In sum, no investment project can be approved if it is not in line with the overall corporate strategy of the business or if the availability of funding for investments, due to future or current cash flow problems, will negatively impact the organization. Although the DCF does not factor in the effects of inflation, many capital investment decisions involve the replacement of existing assets and as such non-financial factors as well as income tax effects are part of the overall decision making approach.
In the following activity, reflect on how you would advise the company using as many aspects of what you have learned in Investment Appraisal. HL students must use the DCF to calculate the NPV.
The present value of Rupee 1 over five years at 10% would be as follows:
A Business in India with an yearly turnover of (in Rupees) Rs300 billion rupees has decided to buy new computers to help improve its business. The computers will be placed in a new location which must be constructed. The cost of the construction as advised by the contractors is Rs250Million and will take 5 years. The cost of 100 Computers will be Rs800,000. The Anticipated Cash flow in all years is Rs56million.
State the advantages and limitations of Investment Appraisal when using the:
1) Payback period
2) Average Rate of return
3) Discounted Cash Flow and Calculating the NPV
ReR